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Publication Date02/09/16

A recent decision by New York Bankruptcy Judge Gerber has both raised the hopes of thousands of good faith shareholder defendants mired in long-running adversary proceedings and provided useful guidance to practitioners regarding the scope of “actual intent” fraudulent conveyance law.

The cases, Weisfelner v. Fund 1, Weisfelner v. Reichman, and Weisfelner v. Hofmann, are fraudulent conveyance suits arising from the In re Lyondell Chemical Co. bankruptcy case, brought against former shareholders of Lyondell that tendered their shares in a 2007 leveraged buyout. The cases are all based on the same underlying facts, and all generally rely on the theory that funds paid to shareholders in the leveraged buyout should have gone to creditors instead. The decision, which dismissed all counts that were based on allegations of “actual intent” fraudulent conveyance, and preserved the counts that were based on allegations of “constructive” fraudulent conveyance, contains a careful exploration of what a plaintiff would be required to prove in order to obtain a determination that a public corporation acted with actual intent to hinder, delay or defraud creditors.

It was undisputed that the Lyondell board had approved the 2007 transactions that included the leveraged buyout-tender offer. The crux of the argument was whether that act could be deemed to have been made by the board with actual intent to hinder, delay or defraud creditors. As framed by Judge Gerber’s earlier decision in Lyondell, because Lyondell was a public company, for the plaintiff-trustee to meet his burden of proof he had to prove that a majority of the board of directors had actual intent to hinder, delay or defraud creditors for intent to be imputed to the company.

The complaint contained specific allegations of improper knowledge regarding only two members of the eleven-person board. The defendants argued that the plaintiff-trustee had failed to satisfy his burden, because there was nothing to show that the remainder of the board intended to hinder, delay or defraud creditors. The plaintiff-trustee responded that intent can be found to apply to the “natural consequences” of an intentional act, and thus that the intent of the majority of the board could be inferred from Lyondell’s bankruptcy filing a little more than a year after the 2007 transactions.

Judge Gerber sided with the defendants, ruling that “intent” means that “the actor desires to cause consequences of his act, or that he believes that the consequences are substantially certain to result from it,” (emphasis in original), based on the standard enunciated in the Restatement of Torts. He concluded that because the amended complaint did not allege specific facts showing that most of the directors had any intention of harming creditors, and that there were no allegations that the two directors were in a position to dominate the remaining directors, the complaint was insufficient as a matter of law.

Looking forward, the decision may be the beginning of the end of the litigation for the shareholder defendants (nearly six years after the complaints were filed). With the actual fraud counts dismissed (subject to an appeal) the plaintiffs are left solely with the constructive fraud counts. But the constructive fraud counts too are vulnerable. The issue of whether constructive fraudulent conveyance actions are subject to the safe harbor of Bankruptcy Code section 546(e) is currently before the Second Circuit in Whyte v. Barclays Bank PLC and In re Tribune Company Fraudulent Conveyance Litigation, and a decision favorable to defendants in those cases could lead to the dismissal of the constructive fraud counts in Lyondell as well.